Working Paper

Demand Uncertainty, Selection, and Trade

Abstract: This paper examines the role of uncertainty on elasticities of trade flows with respect to variable trade costs in a canonical model of trade with monopolistic competition and heterogeneous firms. We identify two channels through which uncertainty impacts trade: through export participation thresholds (the selection effect) and the distribution of shocks governing export selection (the dispersion effect). While the selection effect dampens trade elasticities under uncertainty, the dispersion effect is ambiguous. We develop a methodology for using customs firm-level data to quantify trade elasticities under uncertainty, and the magnitude of each of the two channels through which uncertainty impacts trade. We find that uncertainty amplifies trade elasticities, on average, indicating that the dispersion effect of idiosyncratic firm-level shocks dominates -- though the effect is heterogeneous across industries. The overall magnitude of the endogenous selection mechanism on trade elasticities is small, indicating that the main drivers of trade in this class of trade models are overwhelmingly incumbent firms.

Keywords: Demand uncertainty; Firm size distribution; Extensive margin; Selection; Trade elasticities; Welfare;

JEL Classification: F12; F13;

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Bibliographic Information

Provider: Board of Governors of the Federal Reserve System (U.S.)

Part of Series: Finance and Economics Discussion Series

Publication Date: 2024-06-14

Number: 2024-042